Hedge Fund Eligibility Requirements
Hedge funds are not marketed to the general public or made available in a public offering. Instead, they are offered privately to institutional investors such as pension funds, and to high-net-worth individuals—usually individuals or couples with a net worth of $1 million or more. They are offered to investors through a private placement memorandum (PPM), which explains the investment strategy, fees and expenses, and redemption rules, much like a mutual fund prospectus. It is important to fully understand all aspects of a hedge fund before investing in it. Hedge funds are often structured as limited partnerships, limited liability companies (LLC), or similar entities. The asset manager is listed as a general partner, and the investor clients are limited partners. Hedge funds with $150 million or more in assets under management must register with the U.S. Securities and Exchange Commission (SEC).
Example of a Hedge Fund
The world’s largest hedge fund is operated by Bridgewater Associates, which was founded by Ray Dalio in 1975. Its website makes clear the company’s asset management services are for private investment funds and institutional clients, and it is “not available to provide investment advisory or similar services to most other investors.”
Hedge Fund Fees and Expenses
As with any investment vehicle, the fees and expenses of a hedge fund will impact total return. Hedge funds typically charge an annual asset management fee of 1% to 2% of assets invested as well as a “performance fee” of 20% of a hedge fund’s capital gains and capital appreciation. The investment documents provided by a hedge fund should include a full explanation of all fees and expenses.
Types of Hedge Funds
Hedge funds can pursue a wide range of investment strategies. Assets under management may include stocks, bonds, real estate, commodities, currencies, derivatives, and other alternative assets, many of which are illiquid. Some hedge funds have a variety of holdings, while others may be highly concentrated on a certain asset class. It is important to fully understand a fund’s investment strategy before investing to ensure that it matches your goals and risk tolerance. Hedge Fund Research (HFR), a hedge fund industry data provider, has identified seven strategy categories for hedge funds:
Equity: This is the largest category, with about one-third of hedge funds following this strategy. It may include shorting stocks, combining a long and short strategy, or focusing tightly on a certain sector, such as technology or biomedical. Event driven: Investments are based on mergers, acquisitions, consolidations, and other activity, with a goal of capturing the difference between a company’s current share price and the price at the time of the event. Fund of funds: This is a hedge fund that holds limited partnership interest in a basket of other hedge funds. Macro: Macro funds seek to predict the rise or decline of the broader economy. They are not committed to invest in any specific asset class. Rather, they can invest in equities, currencies, debt, futures contracts, or real estate. Relative value: These funds seek to exploit price differences between closely related investments by simultaneously purchasing and selling them. Because price differences are usually slim, funds that follow this strategy often use leverage to trade more than their total assets under management to produce sizable gains. Risk parity: This focuses on asset allocation diversification to match the amount of risk a portfolio manager is willing to take on to achieve the desired returns. Blockchain: This includes cryptocurrency and related technology.
Hedge Funds vs. Mutual Funds
While both hedge funds and mutual funds use pooled money to invest for growth, there are significant differences between the two investment vehicles.
